Companies and Securities Law

Issue: The issue within the case scenario provided relates to whether Aardvark would be imposed with the liability of the loan taken from Oscar Banking Corp and the settlement amount payable to Lim-ah for the dress. Furthermore, the issue also extends to whether Aardvark would be liable for any debts in the name of Better and whether the charge filed by Oscar Banking Corp with ASIC would entail validity under the “Personal Property Securities Act 2009”.1

Rule: Companies based in Australia are predominantly governed by the “Corporations Act 2001”2 along with financial governance regulated by “The Australian Securities and Investments Commission.” 3

Analysis: Aardvark Holdings Pty Ltd was incorporated in the year of 2014. It includes a number of subsidiaries including Better Nominees Pty Ltd, which came into existence in 2016 and was established for the sole purpose of being the trustee of the Charlie Trust Fund. However, Better Nominees Pty Ltd runs a dry cleaning business on the land owned by Aardvark without paying rent or any separate lease agreement with the Charlie Trust Fund, whose sole beneficiary is Aardvark. Considering the existent provisions relating to the incorporation of companies in Australia, a registered company is treated as an artificial legal entity in accordance to s124 of the Corporations Act. However, there are several exceptions to the principle of the separate legal entity as established in the case of Salomon v Salomon.4 The exception that would be relevant to the working operatives of Aardvark would be The Sham Doctrine as established in the case of Adams v Cape Industries.5 Similar to the judgements in the Adams case, the holding company Aardvark operates Better Nominees as a trustee but uses the company to operate a dry cleaning business. Moreover, the absence of separate lease agreements between Charlie and Better would further impose a tortuous liability on Aardvark for operating Better beyond the scope of the sole purpose stated during its incorporation.

The case scenario further provides that Aardvark is managed by 6 directors. It includes Delta, who is the managing director and Delta’s husband Eric along with Gideon, Hannah, Indigo and Fox. All the directors within excluding Gideon and Hannah own a voting share each in Aardvark while Gideon and Hannah own two and three shares respectively. Aardvark is further depicted to operate on the basis of replaceable rules as covered within s141 of the Corporations Act.6 However, only one exception to the rule is in place within the constitution of the company relating to obtaining loans. It is important to note that the directors of Better Nominees are the same as Aardvark and does not hold board meeting. Moreover, the directors simply sign circulating resolutions for Better Nominees during the board meetings of Aardvark. Both Charlie Trust fund and Better Nominees do not comprise of their individual bank accounts and all the revenue and expenses are maintained and carried out form the bank account of Aardvark.

Another major fraudulent aspect is presented in the accounting policies implemented by the companies. While being incorporated separately, no separate accounts of statements are prepared for the Charlie Trust fund. Furthermore, the trust distributions from the Charlie to Aardvark are maintained as equal to the profits generated by Better nominees through the dry cleaning business. The judgement passed in the matter of “Gilford Motor Co Ltd v Horne” is relevant in this context7, as it led to the establishment of the principle to lift the corporate veil when companies would operate as a mere cloak to avoid existing obligations. Provided that Better Nominees would not have been incorporated as a trustee, the tax obligations would be higher. Aardvark was essentially engaging in tax avoidance in a systematic manner, thus cloaking the operations of the dry cleaning business under Better Nominees.

The aspect of subservience would also be applicable when considering the operations of Aardvark and Better Nominees in terms of the absence of board meeting and separate accounts for the latter. It is a general rule of law within Australia that if a corporation is financially subservient to or in other words, dependent on its parent company, the corporation would be considered to be merely an agent of the parent company as opposed to benefitting from the principle of separate legal entity. The parent company would fundamentally attract any sort of liability that would have otherwise been imposed on the agent in the case of the being a legally valid separate entity with individual articles and statement of purposes. Better Nominees in this regard, would primarily be considered as an agent of Aardvark and any liability or debt incurred by the company would essentially be imposed on Aardvark Holdings Pty Ltd. The judgement passed in the matter of “Smith, Stone& Knight v Birmingham Corporation” is highly relevant in this regard as it led to the establishment of six major principles that would classify agents and separate legal entities in the case of a financially subservience to the holding company.8

The most prominent principles that would be applicable to the operations undertaken by Aardvark and Better Nominees relate to how the profits of Better Nominees are treated as the profits of Aardvark, the appointment of the subsidiary was carried out by the parent company and Aardvark was the head and brains behind the working operatives implemented by Better Nominees. Furthermore, the other principle would also come into effect as the parent company was the governing force behind the subsidiary and it benefitted from the exercise of skill an direction within the subsidiary. Lastly, Aardvark was also in effectual and consistent control of the operations of the subsidiary while depicting the operations being run by one of their employees, Juliet. Naturally, Better Nominees could not be considered as a separate legal entity from Aardvark and would be treated as a mere agent in the case of any dispute or discrepancy.

It is important that the context of the operations would also come into play along with the aforementioned test of principles as established in the case of Smith and Birmingham Corporation. The judgement passed in the matter of “Briggs v Jones Hardy” is relevant in this context, as it established how the contextual back drop of the operations of the parent company and its subsidiary would also constitute important elements when determine the scope and extent of the principle of separate legal entity.9 While the six principles would form the foundation for establishing the case, the context and the nature of operations of the companies would have to be value in an appropriate manner, which in the case of Aardvark and Better Nominees clearly depict that Better Nominees was essentially a sham operating under the cloak of Aardvark.

Moving on to the aspect of Lim-ah’ claims of $400,000 as the mutually agreed upon amount for settlement, the impositions of the liability would certainly fall upon Aardvark as the company would not be differentiated from Better Nominees due to the aspect of lifting the corporate veil. While the settlement was agreed upon with Better and Aardvark was added as a party, the amount would inherently have to be cleared of by Aardvark. Since the statement of claim was served on to Delta, the case scenario depicts Delta approaching Oscar Banking Group, the banking partner for Aardvark. The loan amount included the $400,000 as the settlement claim along with $50,000 as legal expenses and $200,000 as coverage towards the working capital of Better Nominees. It led to the total loan amount exceeding the figure of $500,000, which in accordance to the exception of the Replaceable rules as implemented within the constitution of Aardvark, required a general meeting and ratification by all the directors. Oscar Corp agrees to pay the loan, but requires Aardvark to be the creditor as opposed to Better Nominees and asks for the security of the land upon which the business was being operated.

As per the requirements, an emergency meeting was called by delta the following day by Delta giving a 4 day’s notice period. The notification for the emergency meeting was sent through an SMS and did not include any details in terms of the specifications of the meeting or as to why it was being called. However, this would be in violation of the Replaceable Rules as covered in s141 of the Corporations Act since no exceptions were implemented within the constitution of Aardvark. While informal meetings are allowed through prior notice, the context of the meetings and their specific occasion must be clearly notified to each of the directors. The judgement passed in the matter of “Petsch v Kennedy” is relevant in this regard, as it led to the establishment of the principle that board meetings that were improperly conducted would not comprise of legal merit in the case of a future discrepancies that result due to resolutions taken during the board meeting.10 Additionally, the absence of directors would also nullify the validity of the board meeting. The rule of law as existent within Australia requires companies to allow a period of a minimum of 21 days prior to the date of the meeting.11 A shorter period could be specified provided that all the members and the directors agree to partake in the same and vote before hand.

Furthermore, the meeting is only attended by 4 o the 6 directors comprising of Delta, Eric, Fox and Indigo in person. Hannah fails to see the message and does not attend the meeting, while Gideon is present through a telephonic conversation put on speaker by Delta. The proceedings of the general meeting are not in accordance to the Gideon’s line of through and it would be important to consider that he comprise of three shares of voting power within the operations of Aardvark. Additionally, Gideon is often put on mute during the proceedings of the meeting by Delta and just before the vote is about to be cast, Delta cuts of Gideon claiming that her phone battery was low. Subsequently, the board passes the vote in a unanimous manner approving the loan from Oscar Corp keeping the land as the mortgage.

The activities undertaken by Delta are in gross violation of the duties of directors as put forward by both the common law system and a number of precedents that have been adjudicated within Australia. S181 of the Corporations Act also requires the directors to act in good faith and in best interests of the company12, while s182 prevents the misuse the powers of a director to leverage personal interests. S180 also requires the directors to exercise care and diligence that would be normally expected of a reasonable person. The James Hardie cases are also relevant in this regard, which established that the duties of the directors had to be clearly upheld in general meetings for the resolutions passed to comprise of legal standing.13 Naturally, the activities undertaken by Delta would essentially render the decision to obtain the loan from Oscar Corp as null and void.

Subsequently, as the loan was passed, Gideon and Hannah were inevitably furious at the decision and decide to call a general meeting to rescind the loan contract. A notice period of 21 days was served to all the directors relating to the holding of the meeting at Gideon’s home in Sydney. Naturally, the meeting would be held valid and the resolution would b considered as legally standing as it was attended by Gideon, Hannah and Indigo, who cumulatively comprised the majority of the number of votes in Aardvark. A vote was cast relating to rescinding the contract, followed by which notifications were sent out to the other shareholders. Papas, the loan officer who had passed the loan for Aardvark against the security of the land on which the operations was being carried out was also notified.

Considering the validity of the charge filed by Oscar Corp, it would not be held valid prima facie as the vote passed during the board meeting held by Delta would be held as invalid and not legally standing. However, while the s8 of the “Personal Property Securities Act” excludes mortgage backed securities in cases where the writing evidencing a creation of transfer exists14, land secured by mortgage has been included under the purview of the statute under Regulation 1.5.15 It would be important to gauge whether the loan was sanctioned and credited by Oscar Corp, as early termination fees along with the recovery have been allowed for a compensatory amount in cases involving fraudulent misrepresentation and unnecessary rescinding of contracts.16 The charge for the land for the security backed mortgage, however, would not stand.

Conclusion: In conclusion, the Aardvark would be held solely liable for any part of the loan from Oscar Corp along with the early termination fees, if any. Furthermore, the settlement amount payable to Lim-Ah along with any other debts incurred by Better Nominees would have to be payable by Aardvark as Better Nominees was fraudulently incorporated and was being operated as a mere cloak and sham that was financially subservient to Aardvark. The claim by Oscar Corp would not be valid as the decision to pass the loan through the general meeting vote was obtained in an unfair manner and in violation of the duties of the directors as enforced statutorily. However, the imposition of early termination fees and the recovery of the principal amount would be applicable.

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